Introduction:

QE stands for Quantitative easing, A tranche of Monetary policy employed by Central Banks to Lower interest rates and in turn boost the economy. In short, this is achieved by the New money being used to buy financial assets likes bonds or Mortgage backed securities (MBS) which with a rising price forced on by the relentless buying will force the yield lower. A great article explaining more about QE can be found here by Scramble.

This method has been used a handful of times in economic history, notably by the Bank of Japan a decade ago when they faced the possibility of a Keynesian liquidity trap and deflation. However in the last 5 years it has been used by the US, UK, and the Eurozone.

In the US, there have been 3 rounds of QE, it first came about right after the financial crisis in late 2008 at which point the Federal Reserve started purchasing MBS’s. Alongside cutting the base rate to almost zero, it increased its balance sheet by around $1.4 Trillion. Then in late 2010 it came out with QE2 with an aim to buy $600 Billion of treasuries.

Most importantly is in the last few days – 13th September – the Federal Reserve announced “QE3”

"To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee agreed today to increase policy accommodation by purchasing additional agency mortgage-backed securities at a pace of $40 billion per month."

This is the extract from the most recent Press release from the Federal reserve stating that they are going to purchase $40 Billion of MBS per month, it went on to say how combined with its already running operation twist, it hopes to lower interest rates

"These actions, which together will increase the Committee’s holdings of longer-term securities by about $85 billion each month through the end of the year, should put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative."

The Press release data can be found here.

Initial Effect:

In essence the Release of QE3 came around at the Jackson hole Symposium by Chairmen Ben Bernanke. Ever since then there has been a very definitive trend in financial markets.



As seen by this chart of EURUSD, ever since the Jackson hole symposium the USD has been heavily sold off against the EUR by about 600 pips. This is a very substantial move especially as it has broken many key resistance levels along the way with relative ease.

The reason for the USD to move lower due to QE is purely down to Supply and Demand. The Fed has increased the supply of USD by $40 billion with no new demand will of course lead to a decrease in the value of the USD.

Arguably the most effected instrument would be Gold / XAUUSD for many reasons.

  1. It is a dollar denominated asset and therefore if the Dollar falls, Gold will rise.
  2. Gold is a finite resource as opposed to fiat Currency.
  3. Gold is a Hedge against inflation and with the increase in money supply, inflation is likely and therefore gold will rise
  4. Finally, It is also a risk asset and therefore QE3 adds stability to the market allowing for risk flows to pick up and therefore raise the price of Gold.
Here is a chart of Gold showing its rampant rise in the past 2 weeks.

The price has risen by over 7% since the Symposium.

Long term Effects:

Along with the Announcement by the Federal Open Market Committee on QE, they released data forecasting the 3 main parts of the economy that they monitor under their mandate. The Federal reserve aim to keep Inflation under control while getting lower unemployment and keeping growth strong.

It is hoped that QE3 will boost Aggregate demand within the economy especially on the part of Housing, with the 30 year Fixed rate mortgage down below 4% they hope they can get people buying houses which will lead to jobs in construction industry and that will set of a positive demand cycle, the 30 year fixed mortgages rates can be found here.

The federal Reserve released these 3 charts showing the likely path of each section;

As shown above, they expect Real GDP to continue to rise at a pace of around 3.5% +/- 1% going into 2015 and beyond, they are equally optimistic with the Unemployment rate predicting a steady fall to eventually reach 6.5% by 2015.

Finally, there inflation estimates are flat with a steady 2% increase y/y going into 2015.

Will it work:

The final part of this article is very heated as many say yes, and equally many say no. Famous economist and former chairman of the Fed Alan Greenspan said " QE2 had very little impact on the economy" and many argue there is a significant effect of diminishing returns from successive rounds of QE.

That being said, It is hard to doubt the effectiveness on Yields,

*chart courtesy of Federal Reserve of St, Louis.

Furthermore the wealth effect can be argued as because of the QE's Stock prices rose and as a cause of this people felt better off and more confident about the economy and started to spend more money helping boost the economy further, however evidence of this is hard to find as most things are tainted by the looming Euro zone crisis.

Conclusion:

It is for each individual to decide whether or not they agree with these measures and if it will help improve the economy, there are some sure things such as Gold prices and USD value but how it effects the Unemployment rate is yet to be seen.

Many thanks for reading and hope this helps.

Adrian.


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